By: Robert Mack, Head of Private Client and Trusts, HSM Chambers

The recent unreported judgement of Kawaley J in the Grand Court of the Cayman Islands of Butterfield Trust (Cayman) Limited v A,B,C et. al (Cause 119 of 2020) raised a number of interesting issues in relation to a ‘category two’ Public Trustee v Cooper¹ application brought by the Trustee of a Cayman Islands trust (the “Trust”) involving the appointment of the whole of the Trust Fund to a sole discretionary beneficiary which resulted in the termination of the Trust, issues surrounding the construction of the Trust instrument, and whether (or not) the proposal to appoint out the whole of the Trust Fund to a single beneficiary was ‘detrimental’ to the interests of the minor and unborn beneficiaries.

Robert Mack (Head of Private Clients and Trusts) and Sarah Allison (Partner) of HSM Chambers acted for the Primary Beneficiary in this case.

Case Background

The Trust was a relatively standard discretionary trust for the primary beneficiary (the “Primary Beneficiary”) and her descendants of which the Butterfield Trust (Cayman) Limited was the sole professional trustee. The Primary Beneficiary was the mother of the two minor beneficiaries, defined as “B” and “C” in these proceedings, and together they constituted the whole of the living beneficial class. The beneficial class, however, was not closed as it included the descendants of the Primary Beneficiary, and any such persons who could be added to the beneficial class by the exercise of a power vested in the Trustee to do so.

The Trust Instrument contained an unusual provision which purported to prohibit any Beneficiary from benefiting from the Trust (and be labeled an “Excluded Person”) if they became resident in certain countries, including Australia (the “Exclusionary Provision”). Prior to the creation of the Trust the Primary Beneficiary and her minor children were all residents of Australia, and the minor children were born there and had spent their entire lives in Australia. Prior to the creation of the Trust the family migrated from Australia to avoid being classified as “Excluded Persons” so they would be capable of receiving benefits from the Trust. The Exclusionary Provision was designed to ensure the Trust was as tax efficient as possible, however, it had the unintended side effect of forcing the Primary Beneficiary and the minor beneficiaries uproot themselves from Australia and relocate to a foreign country.

Problems began to arise within the family unit as a result of their ‘forced’ migration from Australia. Despite the family’s attempt to adjust to their new lives, they failed to find their footing and longed to return to Australia. Due to the Exclusionary Provision the family recognized they would be deemed “Excluded Persons” and would remain that way so long as they resided in Australia. Given the fact the Primary Beneficiary and her children were the only living beneficial objects of the Trust, a technical question arose, although it was not touched upon in the judgement, of whether the Trust could continue to subsist without any eligible beneficial objects once the Primary Beneficiary and her minor children were deemed “Excluded Persons”. The Judge, however, was not required to address the issue but conclusions on this technical point varied between the legal advisors involved.

In late 2019 the Primary Beneficiary informed the Trustee of her desire to repatriate to Australia with her family. Both the Primary Beneficiary and the Trustee procured detailed Australian tax advice exploring the tax implications flowing from that decision. After considering the tax implications and all possible alternative options to sustain the Trust one of which included migrating the Trust to Australia, the Trustee determined the best course of action was to appoint out the whole of the Trust Fund to the Primary Beneficiary while she remained a non-Australian tax resident and for the Trust to terminate (the “Proposal”). All other possible options produced problematic technical issues or highly inefficient tax outcomes.

Prior to the Judgement in this matter, one of the minor beneficiaries developed a medical condition which necessitated her urgent return to Australia for specialist treatment. This minor beneficiary was also, due a pre-existing medical condition, more susceptible to contracting the COVID-19 virus and it was determined to be in her best interests that she should return to Australia with her father which in the view of her parents had superior medical facilities to cope with the growing global pandemic.

As a result of that family decision the minor beneficiary was deemed an “Excluded Person”² upon her return to Australia. This raised a further technical issue, as the Proposal would likely transgress an overarching provision of the Trust Deed which prohibited the exercise of any of the Trustee’s powers in such a manner which might directly or indirectly benefit an Excluded Person (the “Overarching Restriction”). The Proposal, if carried out, would therefore likely end up providing an Excluded Person with an indirect benefit as it was almost certain that some of the funds received by the Primary Beneficiary would be used to financially support an Excluded Person (the minor Australian resident beneficiary) over the course of time. Although the Trust Instrument contained a wide power of amendment which was capable of varying the terms of the Trust Instrument to enable an Excluded Person to enjoy an indirect benefit from the Trust, that power was subject to the Overarching Restriction which meant such variation of the Trust Instrument would not be possible without the intervention of the Court (the “Amendment Problem”).

Legal Summary

The combination of the Exclusionary Provision, the Overarching Restriction, and the Amendment Problem, coupled with the fact the Proposal was unquestionably a momentous decision in the life of the Trust, caused the Trustee to apply to the Grand Court of the Cayman Islands to invoke its inherit supervisory jurisdiction over the administration of Cayman Islands trusts in accordance with Section 48 and 72 of the Trusts Law (2020 Revision) (the “Trusts Law”) and Grand Court Rule Order 85, Rule 2 and ‘bless’ the Proposal.

Section 48 of the Trusts Law allows any trustee of a Cayman Islands trust to apply to the Court. “Any trustee or personal representative shall be at liberty, without the institution of suit, to apply to the Court for an opinion, advice, or direction on any question respecting the management or administration of the trust money…and the trustee or personal representative acting upon the opinion, advice or direction given by the Court shall be deemed, so far as regards that person’s own responsibility, to have discharged that person’s duty as such trustee or personal representative in the subject matter of the said application.”

Section 72 of the Trusts Law empowers the Court to vary the terms of a Cayman Islands trust on behalf of minor and unborn beneficiaries provided that any such amendment or arrangement would not be “to the detriment of [such] person.”

Grand Court Order 85, Rule 2 enables trustees, amongst others³, to apply to the Court for the determination of any question arising out of the administration of a Cayman Islands trust or for any relief the Court may grant including for any question arising out of the execution of a Cayman Islands trust. As such, Order 85, Rule 2 compliments Section 48 and Section 72 of the Trusts Law.

The learned judge outlined the factors he considered in reaching his judgement:

1. Does the Trustee have the necessary power to enter into the proposed transaction?
2. Is the Court satisfied that the Trustee has genuinely formed the view that the proposed transactions are in the interests of the Trust and its beneficiaries?
3. Is the Court satisfied that this is a view that a reasonable Trustee (having taken the same enquires and faced with the same circumstances) could have properly arrived at?
4. Is the Trustee operating under any conflict of interest, which would prevent the Court from approving the Trustee’s decision?

The learned judge concluded each of the above factors had been satisfied.

The learned judge concluded the Trustee had the necessary power to distribute the whole of the Trust Fund to the Primary Beneficiary in accordance with the Proposal. The learned judge also accepted that notwithstanding an indirect benefit might accrue to an Excluded Person it nevertheless consented to the variation of the Trust Instrument to remove the restriction prohibiting an Excluded Person from taking an indirect benefit from the Trust and that on the whole the Proposal was in the interest of the beneficiaries.

The learned judge concluded the Trustee had made genuine and thorough enquires regarding the implications surrounding the Proposal, including the Australian tax implications arising which played a significant factor in the Trustee reaching its decision to agree the Proposal.

Lastly, the learned judge found there was no conflict of interest which might prevent him from approving the Proposal, as all parties involved in the Application including the protector and the guardian ad litem for the minor beneficiaries had supported the Application. As such, the learned judge ‘blessed’ the Proposal.

Commentary

The case was interesting for a variety of reasons. It is the first time the Cayman Islands Court has applied the ‘no detriment’ test introduced by an amendment to Section 72 of the Trusts Law (2020 Revision). Prior to the revision of Section 72 of the Trusts Law in 2020, it was necessary to show that any proposed Court sanctioned variation of a trust instrument must be for the ‘benefit’ of any beneficiary affected. It is debatable whether (or not) the Proposal would have satisfied the previous ‘benefit’ test, and the somewhat more neutral ‘no detriment’ test likely made the learned judge’s decision to approve the Proposal easier.

The Exclusionary Provision was quite unusual as the vast majority of trust instruments do not purport to restrict where beneficial objects may or may not reside. The fact the Exclusionary Provision was specifically targeted at the country the family considered home, however well intentioned, actually caused much suffering for the family. Although the Exclusionary Provision was designed to make the Trust as tax efficient as possible, it had the side-effect of fracturing family ties in their home country, and traumatized the minor beneficiaries. It also resulted in much family disharmony. As such, any tax benefits achieved were effectively wiped out by the detrimental effects on the family unit arising from their ‘forced migration’. The learned judge acknowledged that “…genuine family welfare concerns…” played a major role in his decision, thus effectively outweighing any tax benefits achieved by the Exclusionary Provision. This wider concept of ‘benefit’ outside of financial considerations was further exacerbated by the presence of the global COVID-19 pandemic as acknowledged by the learned judge. That such a unique external factor should play into the learned judge’s decision making process is unprecedented in the author’s experience.

Lastly, the fact pattern was highly unique⁴. The Trust was intended to last for multiple generations however it was terminated in under two years from its creation. The Trustee was faced with three very stark choices (1) Take no action and allow the Trust to either fail for want of beneficial objects or (the alternative analysis) allow the Trust to go into ‘hibernation mode’ awaiting the day (if any) that one or more of the beneficiaries ceased to become resident in a restricted country (2) Take some form of action to either migrate the Trust, or earmark a portion of it for the minor and unborn beneficiaries in some manner, despite the prohibitive tax consequences that would arise⁵ or (3) Approve the Proposal.

Looking at all the available options none were wholly satisfactory and each brought its own level of risk for the Trustee. Doing nothing would either result in the Trust failing or the beneficiaries likely never receiving any further benefit from it, implementing some sort of scheme outside of the Trust would attract prohibitive tax consequences capable of wiping out the entire value of the Trust Fund, and carrying out the Proposal meant depriving all but the Primary Beneficiary of any possible financial benefits. In reaching his decision the learned judge took the view that the intentions of the Primary Beneficiary towards her minor children were pure, and that the minor beneficiaries would in due course receive some financial benefits via their mother during their lifetimes. The learned judge also took comfort from the fact the minor beneficiaries remained beneficiaries of other family trusts and were therefore capable of receiving benefits from those family trusts over the course of their lives. In the end, the learned judge was satisfied the Proposal was the best possible option amongst a range of otherwise unpalatable options and ‘blessed’ the Proposal.

1^ [2001] WTLR 901. The ‘category two’ variant being where there is no real doubt as to the nature of the trustees’ powers and how the trustees wish to exercise such powers but because the decision is particularly momentous, the trustees wishes to obtain the blessing of the court for the action on which they have resolved and which is within the scope of their powers.

2^ The way in which the rules of domicile operate for minors from an Australian perspective is that it follows the domicile of the father where the parents are married. This created a separate technical issue in that the minor beneficiary who did not return to Australia was also deemed to have resumed an Australian domicile of dependency. A debate arose amongst the legal advisors as to whether that meant the minor beneficiary who did not return to Australia should also be deemed an “Excluded Person”. This was not touched upon in the judgement and since the Proposal envisioned the Primary Beneficiary alone would receive the whole of the Trust Fund it had no impact on the ruling.

3^ Includes executors, administrators, beneficiaries or an estate or a trust (excluding beneficiaries of STAR trusts), and enforcers of STAR trusts (see Order 85 Rule 2(4)).

4^ The learned judge stated the circumstances were “…strikingly unusual…”.

5^ Australian tax advice concluded that some options under consideration could have resulted in a rate of tax amounting to 100% thus completely wiping out the value of the Trust Fund.